strategy+business

ISSUE 80 AUTUMN 2015

REPRINT 00348

BY VIKAS SEHGAL, JOACHIM REINBOTH, AND EVAN HIRSH

The New Geography of M&ABefore industrial companies sell assets, they must understand the motivations of the full array of potential buyers, especially those emerging in the East.

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The New Geography of M&ABefore industrial companies sell assets, they must understand the motivations of the full array of potential buyers, especially those emerging in the East.

quisitions is rising toward the peaks seen prior to the financial crisis. Ev-ery Monday seems to bring a slew of new announcements of high-profile deals. Historically, the participants in these sales processes have been a relatively homogeneous lot — West-ern companies or private equity firms. And because they tend to speak a common financial language, the attributes they look for have tended to be similar: EBITDA, cash flow, strategic fit.

But the world is changing; the world’s center of economic gravity is moving toward Asia. Most analysts project that China is on a path to overtake the U.S. as the world’s larg-est economy. Even considering its recent growth troubles, Japan sports the third-largest GDP in the world. With its population of 1.2 billion,

by Vikas Sehgal, Joachim Reinboth,

and Evan Hirsh

C onsumer-facing companies have long known that it pays to tailor products for

local tastes as they enter emerging markets. McDonald’s offers a McAloo Tikki sandwich in India — a patty made of peas and potatoes. In China, Kraft’s iconic Oreo cook-ies come with green tea filling. For marketing executives, success is all about understanding the customer.

The same imperative holds true for a different class of professionals who are increasingly finding cus-tomers in emerging markets in Asia: corporate executives in the automo-tive and industrial sectors seeking to sell assets or businesses.

The volume of mergers and ac-

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India is a rising consumer and com-mercial power. So to a degree, it’s not surprising that companies from these countries, as well as from in-dustrial powerhouse South Korea, have become significantly more ac-tive and sophisticated in the global M&A market.

Understanding the strategic in-tent of potential buyers from differ-ent regions and how they may differ from traditional purchasers — and from one another — is crucial. It is important to adopt what we call a market-back approach to position-ing assets or entities for exit. This involves taking a broader view of the potential universe of buyers, under-standing their different needs and values, preparing assets for sale long before the initiation of a sales process so they can appeal to a large array of potential purchasers, and under-standing the nuances and cultural differences that may affect the out-come. To succeed to the fullest pos-sible extent, companies need to move away from the quasi-automated ap-proach of focusing on EBITDA and cash flow, and instead recognize the key business, cultural, and proce-dural attributes that will be impor-tant for buyers in the future.

Gauging Value

Companies that are considering sell-ing assets must ensure that their in-vestments are channeled in a way that will attract the new cast of buy-ers. But value is in the eye of the be-holder. A host of factors can make a company or business division par-ticularly attractive — for example, fundamental performance (growth and EBITDA margins), intellectual property and proprietary technol-ogy, and the customer base and di-versified geographic exposure. Dif-ferent buyers from around the globe

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will place different emphases on these attributes.

Focusing only on profitability and growth in cash flow is a proven method of enticing U.S. private equity buyers. And Western buyers generally tend to place a higher pri-ority on strategic fit. But a Chinese family-owned company may not care as much about last quarter’s EBITDA, especially if the deal will allow the company to obtain valued

technology that it can further de-velop for the massive local market. By contrast, a state-owned enterprise (SOE) in China has to take into ac-count broader public agendas, and may be more interested in maintain-ing employment in its province than in hitting a cash-flow multiple. Companies in both India and China often place a higher weight on brand than Western companies might, be-cause acquiring premium brands al-lows them to differentiate them-selves from local competition.

As a result, investments by cur-rent owners that may not make much sense from the standpoint of short-term profitability — such as pumping up investments in R&D — can nonetheless add value when it comes to pitching the company to this new global audience. The intel-lectual property and know-how gained can trump the value that was lost by having a slightly lower EBITDA margin.

As an example, consider a trans-action announced in September 2014. Ficosa, a Spanish manufac-turer of rearview mirrors for cars,

entered into a capital and business alliance with Japanese technology company Panasonic. In the years prior to the deal, Ficosa had invested in building electronics into the mir-ror to differentiate itself from the competition. Whereas many West-ern peers focused on how such a partnership could work in terms of cost synergies, Panasonic viewed Fi-cosa as an opportunity to gain valu-able “real estate” in the driver’s vi-

sion area. The Japanese hardware and software supplier saw taking a 49 percent stake in Ficosa as an op-portunity to leverage its own auto-motive technologies and gain fur-ther access to certain European car manufacturers such as BMW. By investing in R&D, Ficosa expanded the market of potential buyers, gave itself more options, and likely wound up with a stronger valuation.

One important differentiating factor to consider is the “cost of constitution.” That is, when buyers from emerging markets evaluate opportunities, they may ask them-selves how much it would cost them to build, from scratch, a business comparable to the one currently for sale. In 2010, Geely, a private Chi-nese car company, acquired Volvo Cars of Sweden from Ford Motor Company. Geely had approached Ford as early as 2007 about a poten-tial acquisition, even though Volvo’s business was sagging. Ford — and other Western automakers — didn’t see much value or potential for the brand. However, Geely’s chairman and founder, Li Shufu, clearly iden-

Investments by current owners that may not make much sense from the standpoint of short-term profitability can add value when it comes to pitching the company to a new global audience.

tified Volvo as a strategic stepping-stone for his own company. This acquisition would enable Geely to become one of the leading private Chinese car manufacturers in a domestic market otherwise domi-nated by SOEs. It would also allow Geely to gain control of a strong brand that would give it an inter-national presence — both rarities for Chinese carmakers at the time (see exhibit).

Understanding Diversity

Just as the rise of Asian buyers has brought a wider range of motiva-tions to the scene, it has also pre-sented a wider range of ownership structures. In Europe and the U.S., companies are typically classified as publicly held or privately held, and the latter are often owned by fami-lies or financial sponsors. Asian companies, however, inhabit a much more diverse spectrum. Their par-ticular circumstances can influence

Exhibit: Rising Involvement of Asian BuyersThe proportion of automotive deals with an Asian buyer involved in the final round has risen sharply in the last decade. So too has the portion of transactions in which an Asian company was the purchaser.

Source: CapitalIQ, Rothschild

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in which Asian companieswere involved in thefinal round

Percentage of automotive deals...

won by Asiancompanies

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management’s strategic agenda, af-fect financing, and enable M&A to be seen in a much broader context. In Japan, many companies belong to keiretsu: conglomerations of busi-nesses linked by cross-shareholdings to form a robust corporate structure. Therefore, it is important to under-stand how an asset may fit into the larger strategic puzzle of a potential Japanese buyer. SOEs in China are often able to obtain favorable fi-nancing from local banks to support a strategic acquisition.

Sellers must also become com-fortable with a broader range of sales processes. In our experience, com-pared with their Western counter-parts, Asian buyers often require a lot of time as they assess opportuni-ties. The pace and priorities not only reflect the overall organizational structures and decision-making pro-cesses, but can also typically also be traced to cultural factors. Not al-lowing some extra time for a Japa-nese player to conclude detailed and rigorous due diligence may jeopar-dize a potentially important buyer and value creator. Having an advisor with a local team who understands the potential buyer is particularly important when involving Chinese parties, given the gauntlet of regula-tory approvals through which any deal must pass.

The key is to start early in plan-ning for a more diverse world. Cereal companies don’t wait until the boxes are on the shelves of local retailers to start thinking about how their prod-ucts will appeal to new consumers. The process begins much earlier — with everything from the recipe to the design of the box. Similarly, own-ers of corporate assets have to think further in advance about potential buyers of their assets, and the con-cerns and needs of these buyers.

Taking a market-back approach and segmenting buyers may allow for the construction of a better strat-egy for grooming an asset over the duration of the ownership period. Of course, earnings and financial fundamentals will continue to be paramount in the eyes of many buy-ers. But the range of factors that may be considered has expanded. Whether parties ultimately negoti-ate over a multiple of EBITDA, or the future value of a technology, or the economic stability a buyer could create in a specific geographic area if running the factories, or the impos-sibility of the buyer’s accomplishing a desired goal without the new asset, the goal is the same: To end up with a best final offer that sits at the real value threshold of a buyer. Knowing the motivations of all potential cus-tomers will soon be part of every smart seller’s strategic agenda. +

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Vikas Sehgal vikas.sehgal@rothschild.com is a partner and executive vice chairman at N.M. Rothschild & Sons in London, and is the global head of the bank’s automotive sector.

Joachim Reinboth joachim.reinboth@rothschild.comis an assistant director at Rothschild.

Evan Hirsh evan.hirsh@strategyand.pwc.com is a leader with Strategy&, PwC’s strategy consulting group, in Cleveland. He specializes in the automotive and industrial sectors.

The authors thank Mihir Sarkar and Ambika Sahay Verma for their research support.

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